CIBT Education Group Inc. (TSX: MBA) Agreement to Sell Viva for a Significant Return on Investment. Sector/Industry: Education Services

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1 Siddharth Rajeev, B.Tech, MBA, CFA Analyst July 26, 2018 CIBT Education Group Inc. (TSX: MBA) Agreement to Sell Viva for a Significant Return on Investment Sector/Industry: Education Services Market Data (as of July 26, 2018) Current Price C$0.82 Fair Value C$1.63 Rating* BUY Risk* 3 52 Week Range C$ C$0.87 Shares O/S 78,878,540 Market Cap C$64.68 mm Current Yield N/A P/E (forward) N/A P/B 1.5x YoY Return 9.3% YoY TSX 8.5% *See back of report for rating and risk definitions Highlights In May 2018, CIBT s Limited Partnership ( LP ) entered into an agreement to sell its ownership in the Viva property for $55.5 million, which we estimate reflects a gain of 292% for equity investors (over a period of 41 months). The property will continue to operate under the GEC brand, as CIBT will lease the building from the purchaser for five years. Approximately $50 million in equity has been raised for the recently launched GEC Richmond. This $230 million project, covering 412,000 sq. ft., is likely to include an office tower and two residential towers. Management expects to receive an occupancy permit on GEC Pearson this month, and fully lease out the property (310 beds) over the next six months. In Q3-FY2018, revenues increased 85% YOY, to $22.83 million, but were slightly lower than our forecasts. Nine-month revenues were up 49% YoY to $54.70 million. Vancouver s rental market remains extremely tight. We believe the Bank of Canada ( BoC ) decision, earlier this month, to raise the overnight lending rate will continue to increase demand for rentals. We are raising our fair value estimate from $1.51 to $1.63 per share. *The net profit / loss figures include CIBT s share of the net profit / loss and non-controlling interests Fundamental Research Corp. 15+ Years of Bringing Undiscovered Investment Opportunities to the Forefront

2 Page 2 Update on the Vancouver RE Market Despite the recent slowdown in real estate sales, Vancouver s rental market remains extremely tight with rental rates at historical highs, and vacancy remaining low. According to the CMHC, the vacancy rate in Metro Vancouver for bachelor suites (CIBT s primary target market) is just 0.7%. According to a recent Goodman Report, 17,229 units are currently under construction/development/planning in Metro Vancouver. These units will take at least five years to be completed, and will not be sufficient to meet demand as Vancouver s annual population is growing by 30,000-35,000. The total number of apartment units in the City of Vancouver has only increased by 0.6% p.a. from 2010 to Multi-family properties in the Greater Vancouver area experienced record high transactions in 2017, as shown in the table below. Although the number of buildings sold dropped YoY (174 to 150) in 2017, the total number of units increased by 28% (3,933 to 5,029). The total dollar volume of transactions increased 47% to $2.17 billion Fundamental Research Corp. 15+ Years of Bringing Undiscovered Investment Opportunities to the Forefront

3 Page 3 We expect the record high home prices and rising mortgage rates to continue to increase demand for rentals. The Bank of Canada ( BoC ) has raised the overnight lending rate four times over the past 12 months (July 2017, September 2017, January 2018, and July 2018). Canada - overnight lending rate Source: Bank of Canada We continue to believe the market conditions remain highly conducive for CIBT s real estate business. GEC s RE Portfolio A map showing CIBT s eight projects are presented below. Source: Company 2018 Fundamental Research Corp. 15+ Years of Bringing Undiscovered Investment Opportunities to the Forefront

4 Page 4 The table below shows an updated summary of the acquired projects and the projects under development. Note that a few of our estimates shown in the table below may not be in line with management s estimates. Project Summary *Ownership may change with project financing * Our preliminary rental income estimates were based on approximately 10% of the cost price for each project. Source: Company and FRC The following were the key developments since our previous report in May 2018: Viva In May 2018, CIBT s LP entered into an agreement to sell its ownership in the property. The sale is expected to be completed in early August. The cost-base is estimated at $38 million ($6 million in equity plus $32 million in debt), and the sale price is estimated at $55.5 million, implying a profit of approximately $17.5 million. We estimate the sale price reflects a cap rate of 3.5% to 4.0%, which is in line with the market average. The limited partners invested $6 million, which we estimate implies a return of 292% over a period of 41 months. CIBT will receive approximately $3.5 million of the $17.5 million profit, for its 20% interest. The property will continue to operate under the GEC brand, as CIBT will lease the building from the purchaser for five years. Leasing fees were not disclosed. The company had launched GEC Richmond in March 2018 (eighth GEC location) Fundamental Research Corp. 15+ Years of Bringing Undiscovered Investment Opportunities to the Forefront

5 Page 5 According to the Purchase and Development Agreement with a Vancouver developer, CIBT s LP is required to pay deposits totaling $65 million by December 2018, of which, $50 million has been paid to date. This $230 million project, covering 412,000 sq. ft., is likely to include an office tower and two residential towers. Management expects to raise an additional $20 million in equity by the end of this year. CIBT will receive a 20% equity interest in the project in return for approximately $14 million in development fees. As the new project in Richmond will be developed as GEC Richmond, management is considering renaming the project, on previously purchased land in Richmond, from GEC Education Super Center to Cyber City. Mega Center (Surrey) - rezoning approval is expected by Q4-FY2018. Construction is expected to start in early 2019, and completion is expected in Pearson Management expects to receive the occupancy permit this month, and fully lease out the property over the next six months. A mortgage has been approved for approximately $37.40 million. Sale of four commercial ground floor units at GEC Burnaby Heights for $6 million, with expected closing by the end of this month. Overall, approximately 840 beds will be in operation once Pearson is operational. Revenues up 85% YOY in Q3 In Q3-FY2018, revenues increased 85% YOY to $22.83 million, but were slightly lower than our forecasts. Nine-month revenues were up 49% YoY to $54.70 million. The table below summarizes the company s key divisions and their revenues. Revenues and Margins by Segment Source: Company Data 2018 Fundamental Research Corp. 15+ Years of Bringing Undiscovered Investment Opportunities to the Forefront

6 Page 6 The revenue growth came primarily from development fees, rental revenues, and educational revenues. Educational revenues (excluding China) were $11.15 million, up 18%, but were lower than our estimate. We have revised our FY2018 revenue forecast from $48.5 million to $46.5 million. The company reported rental revenues of $2.71 million, up 30% YoY. Revenues came from Viva Suites Hotel, Granville, and Burnaby Heights. We were expecting GEC Pearson to be operational in Q3, but are still expecting a significant increase in rental revenues as Pearson becomes operational. Our FY2018 revenue forecast has been adjusted from $12.22 million to $10.38 million. The company reported development fees of $8.02 million in the quarter versus nil in Q We are adjusting our forecast for FY2018 from $18.93 million to $16.93 million. Based on the above, we are revising our FY2018 revenue estimate from $84 million to $78 million. We are also adjusting our FY2019 estimate from $90 million to $88 million. Note that we have raised our net profit forecasts as discussed later in this report. Gross margins beat our estimates and were 72% in Q3-2018, versus 51% in Q Margins increased due to the high development fees this quarter, which have a 100% margin. We are raising our gross margins estimate for FY2018 from 61% to 62%. Margins Source: Company Data General and administrative ( G&A ) expenses increased by 21% YOY to $8.05 million, and were slightly higher than our expectations. Our FY2018 estimate has been adjusted from $30 million to $32 million Fundamental Research Corp. 15+ Years of Bringing Undiscovered Investment Opportunities to the Forefront

7 Page 7 EBITDA was $8.24 million in Q3-FY2018, versus -$0.38 million in Q3-FY2017. EBITDA, including the gain on property valuations and asset sales, we estimate, was $10.26 million in Q3-FY2018. Note that the company s reported figures are slightly different from our calculations. For the nine-month period, EBITDA (including gain in property value) was $21.47 million in FY2018, versus $8.50 million in FY2017 The total gain in the valuation of properties was $nil million in Q3-FY2018, versus $1.49 million in Q2-FY2017. Since the inception of the real estate business, the company has reported total gains of $36.50 million. The table on page 4 shows our estimates of the expected increase in valuations of the assets. We estimate the company will report a total valuation gain of $62 million over FY2018 and FY2019. CIBT reported net income of $7.96 million in Q3-FY2018, versus -$1.41 million in Q3- FY2017. After deducting non-controlling interests, CIBT reported net income of $8.50 million (EPS: $0.11) in Q3-FY2018, versus -$2.27 million (EPS: -$0.03) in Q3-FY2017. For the nine-month period, the company reported $11.77 million (EPS: $0.15) in FY2018 versus $3.03 million (EPS: $0.14) in FY2017, after deducting non-controlling interests. After making all the above mentioned changes, and an expected $17.5 million gain from the sale of Viva, we are adjusting our FY2018 estimate from $16.92 million / EPS: $0.21 to $17.09 million / EPS: $0.22. We are also adjusting our FY2019 estimate from $17.35 million / EPS: $0.22 to $21.37 million / EPS: $0.27. Note that these figures are net of non-controlling interests. Cash Flows Free cash flows were -$59.24 million in the first nine months of FY2018, versus -$28.10 million in the comparable period in FY2017. Balance Sheet Source: Company Data At the end of Q3-FY2018, the company had $10.57 million in cash (excluding restricted cash shown). Debt to capital was at 44% Fundamental Research Corp. 15+ Years of Bringing Undiscovered Investment Opportunities to the Forefront

8 Page 8 Source: Company Data Working capital and the current ratio were -$73.72 million and 0.3x, respectively. The negative working capital was due to $60.35 million in mortgages, and $23.21 million in deferred revenues. Stock Options and Warrants Valuation and Rating The company had 1.87 million options (weighted average exercise price $0.72), and 2 million warrants (weighted average exercise price $0.75) outstanding million options and all warrants are currently in the money. The company can raise up to $2.75 million if these options and warrants are exercised. We are raising our fair value estimate to $1.51 from $1.63 per share, as our valuation of the student housing division increased. The following table summarizes our valuation. Source: FRC / S&P Capital IQ 2018 Fundamental Research Corp. 15+ Years of Bringing Undiscovered Investment Opportunities to the Forefront

9 Page 9 Risks The following risks may cause our estimates to differ from actual results (not exhaustive): Competition in the private education business in Canada is high. Real estate development and financing risks associated with GEC. Health of the rental market in Vancouver. The company s profitability is highly dependent on the health of the student housing real estate market in the Greater Vancouver area. Although the company has been able to pursue cheap acquisitions in the past, there is no guarantee they would be able to continue to do so going forward. Exchange rate risks exist, but are not significant, as revenues from China account for less than 10% of total revenues Fundamental Research Corp. 15+ Years of Bringing Undiscovered Investment Opportunities to the Forefront

10 Page 10 Appendix 2018 Fundamental Research Corp. 15+ Years of Bringing Undiscovered Investment Opportunities to the Forefront

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13 Page 13 Fundamental Research Corp. Equity Rating Scale: Buy Annual expected rate of return exceeds 12% or the expected return is commensurate with risk Hold Annual expected rate of return is between 5% and 12% Sell Annual expected rate of return is below 5% or the expected return is not commensurate with risk Suspended or Rating N/A Coverage and ratings suspended until more information can be obtained from the company regarding recent events. Fundamental Research Corp. Risk Rating Scale: 1 (Low Risk) - The company operates in an industry where it has a strong position (for example a monopoly, high market share etc.) or operates in a regulated industry. The future outlook is stable or positive for the industry. The company generates positive free cash flow and has a history of profitability. The capital structure is conservative with little or no debt. 2 (Below Average Risk) - The company operates in an industry where the fundamentals and outlook are positive. The industry and company are relatively less sensitive to systematic risk than companies with a Risk Rating of 3. The company has a history of profitability and has demonstrated its ability to generate positive free cash flows (though current free cash flow may be negative due to capital investment). The company s capital structure is conservative with little to modest use of debt. 3 (Average Risk) - The company operates in an industry that has average sensitivity to systematic risk. The industry may be cyclical. Profits and cash flow are sensitive to economic factors although the company has demonstrated its ability to generate positive earnings and cash flow. Debt use is in line with industry averages, and coverage ratios are sufficient. 4 (Speculative) - The company has little or no history of generating earnings or cash flow. Debt use is higher. These companies may be in start-up mode or in a turnaround situation. These companies should be considered speculative. 5 (Highly Speculative) - The company has no history of generating earnings or cash flow. They may operate in a new industry with new, and unproven products. Products may be at the development stage, testing, or seeking regulatory approval. These companies may run into liquidity issues, and may rely on external funding. These stocks are considered highly speculative. Disclaimers and Disclosure The opinions expressed in this report are the true opinions of the analyst about this company and industry. Any forward looking statements are our best estimates and opinions based upon information that is publicly available and that we believe to be correct, but we have not independently verified with respect to truth or correctness. There is no guarantee that our forecasts will materialize. Actual results will likely vary. The analyst and Fundamental Research Corp. 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